Pay off rental mortgage or reinvest?

104 Replies

Hello next year I will be buying my first rental property. I wanted to get your opinion on paying off your rental property mortgage one at a time before buying the next rental or not? The way my numbers will work out is this time next year I should be saving a good amount per month so I used rough numbers to figure out when I could retire. Based on the method of paying off rental property before buying the next one for a $150,000 dollar home that rents for $1500, every time you pay one off the cash flow would grow from around (150-200) to (1150-1200) which you could then reinvest into the second property. Over the course of 15 years you could get 7 properties paid off making a pretty nice amount per year. I am struggling to see the benefit of just buying rentals and not paying them off because to get that much cash flow you would need around (35-47) properties which would take longer to save up and get that many? Am I way off here? Now I know 150-200 cash flow on a $150,000 puts me around 5% CoC return and I should be looking for around 12% but I am basing these numbers off what I can just easily see on zillow. Do I need to go back to the drawing board because I have missed something important here?

I think I struggle with the same Brandon, I'm currently reading "Retire Early with Real Estate" They talk about multiple strategies in the book. You should really read it, I like that they give examples but also cons/pros regarding the strategy their is no wrong or right answer, its what your comfortable with.

Paying off rental mortgages costs you money...it doesn't save you anything.  If those properties are cash flowing, then your tenants are paying it off.  The only cost to you is what comes out of your pocket.

Don't mistake total cost for your cost.  They are not the same thing.  The total cost isn't as important as how you pay for it.

If you buy a property all cash that cost $100k, that property cost you $100k

If you bought that same property with 20% down ($20k), and financed the rest. with a yearly debt service of about $5k/year over 30 years, the total cost for this property would be $170k...but your cost would only be $20k.

Your tenants are paying off your debt for you, and building up equity for you...and it's free. Why would you want to pay for it if you don't have to?

This is a good thought, Brandon. The conservative me says that this would be the approach I'd want to take but then it seems what experienced investors say is that you take advantage of low-interest loans to build up your portfolio. The cash flow number you mentioned of 150-200 sounds too low for a $1500/mo property unless the mortgage, taxes, and insurance are super high.

At any rate, I am going to be jumping in the next few years and I will probably use cash flow for one property to help pay for the down payment for the next (as opposed to trying to pay them off entirely). Even doing that can take a while if you are only cash flowing a few thousand dollars a year so I will probably be adding additional savings to accelerate that process.

Originally posted by @Jay C. :

This is a good thought, Brandon. The conservative me says that this would be the approach I'd want to take but then it seems what experienced investors say is that you take advantage of low-interest loans to build up your portfolio. The cash flow number you mentioned of 150-200 sounds too low for a $1500/mo property unless the mortgage, taxes, and insurance are super high.

At any rate, I am going to be jumping in the next few years and I will probably use cash flow for one property to help pay for the down payment for the next (as opposed to trying to pay them off entirely). Even doing that can take a while if you are only cash flowing a few thousand dollars a year so I will probably be adding additional savings to accelerate that process.

You realize all you're doing is paying more for the property with every added payment, right.  You're not saving anything.  Every time you "buy" your equity, it costs you.  Every time your tenant buys it for you, it's "free" to you.  The interest is paid for by the tenants.  Your cash flow goes down every month you use your own money (from your pocket or from other cash flow properties) to pay down the principle.

In the example I gave above, if you paid $100k in cash for a property and had $10k per year in cash flow, it would cost you $100k for that property...and since you don't make a profit until you recover all of your costs ($100k), it will take you 10 years to break even.  The $100k in equity that you paid for, in't a plus...it's the same money you had in the bank...just in a different location.  the difference is, in the bank it can be invested in another property.  In the house as equity, it's dead.

Same property, but you only paid the DP = $20k. You only make $5k/year, but since you only paid $20k for the property, it will only take you 4 years to recover your cost. This means from years 6 - 10 (when the first REI is still waiting to recover the last $60k of their cost), you will be profiting $5k/yr. 6 years of $5k = $30k in profit...when the other REI finally breaks even.

If you both started with the same $100k, you could do this 5 times...from the start.  That means 5 times $5k/year = $25k/year.  6 years = $150k in profit at year 10.  That also means 5 properties appreciating at the same time...instead of just 1.

 

@Joe Villeneuve, @Jay C @Fernando M Thank you all for the feedback. Yeah the ultra conservative in me is thinking this path because of the point of if i pay of a property and move forward I can always afford the rent payment of the rental if the tenant leaves until I need to rent it out again. If i had 5 and they all left would be sooooo screwed that month... You do make a point about the suggestion of your money in a house vs in a bank. I re-looked at my numbersfrom what I am showing paying one off at a time like I mentioned you could get 7 houses paid off in 15 years reaching that magic 7k a month in cashflow. My previous numbers didn't account for the cash flow bonus stacking each year to help buy properties and in the same 15 year span I could get just over 7k per month so definitely not bad. Thanks Joe for explaining that a bit more it caused me to see it a bit more clearly! Now i just have to plan on finding 28-42 good deals rather than just 7. No pressure :P

@Brandon Miller

I think you will find that once you buy one property you'll get the real estate bug, and the last thing you will want to do is lock money up in the first house when you could be saving for the next house.

Plus 7k is nice but consider what financial security you could build with 35-47 of those suckers paid free and clear one day to leave to your kids/charity/whatever.

Ask me how I know...

For me Joe I will hedge some of that risk by having some cash and also money invested in taxable brokerage accounts. I like having some liquid investments I could draw from if necessary without having to park a lot of cash.


@Joe Villeneuve

Wow you really make lots of sense the way you break things down. Ok now if you don't mind what about one this situation. I'm currently buying 3 properties and own 1(1 is paid off in full that I have been pulling the equity out of) and I'm in the process of buying a 4th and then I will have to be done for awhile (dang this is SO addicting) I am inheriting $20K so far from my father's estate. One of the 4 properties is the current place I live in. It's a Duplex and I live in the smaller side of the property and my daughter and her family live on the other side. The mortgage payment is $1046.32 and my daughter pays $650 of that. I pay the rest. Since her rent payment will never get the investment property paid off should I throw the $20K on that property? And put even more on the loan as I can? With soon having 4 loans going I'm pretty much down buying for the moment. We currently live in 1 property, short term rent 2 of the properties and the 4th property we are buying we are inheriting a long term tenant so will long term rent for now until the tenant leaves then we will short term rent it. I think I have pushed my limit with what we can get from our credit union. And with the 4th property costing more than we have planned I offered to put $75K down on it. (the proceeds from a property I sold recently) Not sure if I should have done that but it already set to be paid. I would appreciate your advice!

 


Updated 3 months ago

Made a new post on this here with a deal from the credit union: https://www.biggerpockets.com/forums/311/topics/862231-should-i-pay-down-on-this-mortgage-deal-from-credit-union

@Brandon Miller   If your plan it to buy more rentals, why would you pay down the mortgage on one property?  Save that money to use as a down payment for your next property.  If you have multiple properties that are cash flowing, it also means if you have a vacancy at one for one month, the money from the others will help cover that short fall.  You still want to have some money kept aside for unexpected repairs.

@Brandon Miller

I was in the same mindset as you when I started. I guess it's all of those Dave Ramsey videos that I had to watch in economics during my high school years. Lol If you're wanting to get Financial Freedom quickly, you're going to want to leverage. Principal pay down by tenants is one the best factors about REI. Hope this helps! Good luck in your journey! ๐Ÿ‘๐Ÿป๐Ÿ‘๐Ÿป

I have been trying to get all the Dave Ramsey stuff out of my system. Dave's stuff is good for getting out of and avoiding high-interest consumer debt. It should not keep ppl from taking calculating risks on relatively low-interest mortgages for investment properties.

Speaking of which what is a good rate (knowing they are higher for houses that aren't primary residency)? I was poking around the other day and saw that I could get 5% for an investment property, not sure if I could get lower.

Jay C. I'm in the process of buying an investment property now with a 3.6% interest rate! Just 2 years ago I had a property where I was paying 5.87% for an interest rate until I sold it this year. Huge difference. I have gotten as low as 3.5% and that was on a property we purchased in April.

@Brandon Miller

To make simple, its a matter of leveraging or not. If you can pay off and like to get rid of debt quickly ( in other words, dont like much leveraging), then you could have a shorter tenor mortgage. Helps to pay it quickly while saving less as interest in loan will be 20 x higher than ur savings.

If you are confident with debt and leverage, you can get the same savings and get another property earlier. With the same strategy you will have even more cash flow, but will run a bigger risk. If get properties empty for any reason, you will need good reserves to pay both mortgages...

I am not a big fan of superleverage, so i would reduce in the first property tenor, and in 2/3 tears would have enough equity to got to other house...

@Joe Villeneuve

loving your advice.

Question for you-

We have a 15 year mortgage on our first rental w/ 9 years remaining (was our starter home) - leveraging for down payment into the next which will be our second rental (and hopefully doing many more in the same way over time).... the new tenants would be paying doesnโ€™t the equity loans.. is this a good approach ?

"Over the course of 15 years you could get 7 properties paid off . . . "
---------------------------------
First question: How do you get to those 7 properties? If you already have them, and look to start winding down, that makes sense. If you are just starting out, but you have a chunk of money and can handle 7 properties now, then buying them and then working down the debt makes sense, too -- if you don't want to get much bigger than seven properties. Spending thirty years acquiring the 7 seven properties because you are paying one off and then adding the next one makes your above statement irrelevant.

Second question: How much risk are you willing to take and still sleep at night? Landlords without debt are in better position (I didn't say great, I said "better") to weather downturns and rent moritoria than those leveraged to the hilt. Check with your wife before you answer.

Third question: What is your desired scale of operation? If you want to be small and solid then a low growth, high return, probably suits you better. If you want a hundred doors in the next 15 years, you won't do it without leverage.

Fourth question: What are the alternate uses for you money? What are the returns on those investments?

Ignore ideological answers like "always be buying" and other brainless crap like that. ideology is an excuse for not thinking. Answer for yourself the above questions and proceed accordingly. You might wind up with a hybrid approach, or with a straight line doctrinaire answer. The answer is in your gut.

I'm solidly in the @Joe Villeneuve camp, for all the reasons he's listed, and for the eloquence he used that I couldn't.

One reason I don't pay anything off early is the small gains it would accomplish. For your $100k property, 80% financed at 3.5%, you're paying $359 in Principle and Interest. If it's a 1% rule property, you're grossing $1000/mo. Good Job! but your cashflow isn't $641, it's more like $1-200. You've got a lot of fixed expenses mixed in there. The other half of the mortgage payment, Taxes & Insurance, maintenance reserves, management fees, utilities, etc. Paying it off only increases your cashflow by the $359. That's not much, especially when that $80k could have grown, been leveraged, and/or compounded elsewhere, rather than sitting in a hole in the ground and hoping for market appreciation.

The other one that hasn't been addressed yet is the advantage long term debt has against inflation. My P&I will never increase on a fixed rate loan, but the dollars I use to pay it will become cheaper. Fixed rate mortgages are little financial time capsules. Today, your $1000/mo mortgage payment might seem like a huge burden when you're making $50k. But in 20 years, if you're at the same level in your field, but making $100k, that mortgage payment will feel a lot easier to pay. The dollars are cheaper, and we have more of them in the future.

@Brandon Miller

I understand you wanting to pay the rental properties off ASAP, but as @Joe Villeneuve has stated let your tenants pay your expenses. I agree, your property costs you nothing once you retrieve your initial investment of 20K as in the example of buy a property for 100K with 20% down. There are so many tax benefits as well with mortgage interest, property taxes, depreciation, etc. Look at it from the cash on cash (CoC) perspective. I like to invest where my cash flow is at the $300 and over. If I am going to buy traditional that's 3600 a year and it will take me approximately 5.5 years to get my money back with a 20K investment. That's to long for me to get my money back. This is why I like the BRRRR strategy. I can recoup my money back in 12-18 months and in some cases less.

Talk to your CPA about the advantages of being in business.  It provides so many advantages that you can cash flow and still deduct on paper a tremendous reduction to your W-2 income.  You will be miles ahead by being in business.  Look at the whole picture.

Originally posted by @Kimberly Carver :

@Joe Villeneuve

loving your advice.

Question for you-

We have a 15 year mortgage on our first rental w/ 9 years remaining (was our starter home) - leveraging for down payment into the next which will be our second rental (and hopefully doing many more in the same way over time).... the new tenants would be paying doesnโ€™t the equity loans.. is this a good approach ?

 Numbers???

Wait BUT if we pay down a loan early that money you put down switches over to equity. Then can't you just use that equity to continue to grow? So use the equity instead of cash going forward? That's how I got going so quickly was I had a commercial with residential property I had paid off in full about 10 years ago. (appraised at about $370K) When I purchased my first short term rental property I didn't have to put any cash money down on it. I just used the equity from my paid off property to buy it without having to put any cash money on it. Then from their going forward I just had to put 10% down on future properties. That has saved me having to fork over lots of cash and that is how I'm purchasing my 6th investment property. (2 I sold for a nice profit)